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A bit more on administrative costs

July 6, 2009 1:48 pmJuly 6, 2009 1:48 pm

After rereading my earlier post, it occurred to me that it might be useful to lay out the logic of the argument. What we observe is that private
insurers spend a much larger fraction of their receipts on administration than Medicare does. Heritage asserts that this is because administration costs are proportional to the number of beneficiaries, not spending,
so Medicare has low percentage costs because its elderly beneficiaries are so much more expensive than average.

So how would you test this assertion? I can think of two obvious approaches: (1) Compare the administrative costs of different systems serving similar populations (2) Compare the administrative costs of similar systems
serving different populations.

And we can do both of these things.

Medicare Advantage plans are private insurance serving the elderly population. So this is a case of different systems serving similar populations. (Medicare Advantage clients are probably somewhat healthier than the
average senior, but the average cost of their health care is still very high.) If costs depended mainly on number of people, these plans should have low administrative costs as a percentage of spending. They don’t
— their numbers look like those of private insurance in general.

Meanwhile, other countries have Medicare-like systems that cover low-cost as well as high-cost individuals. Canada’s system is actually called Medicare. So this is a similar system covering a different, lower-cost
population. If costs depended on the number of people, Canada should have high administrative costs; in fact, its numbers look like those of American Medicare (actually even better.)

This seems like fairly overwhelming evidence that single-payer systems do, in fact, have low administrative costs compared with private insurers. To argue that this doesn’t clinch the case, you have to resort
to pretty desperate expedients; for example, one of my commenters says that the CBO study of administrative costs can’t be trusted, because Democrats control Congress. (The CBO bends over backwards to be
nonpartisan — and anyway, the study was done in 2006, when Republicans were still in control.)

I know that some people find that answer unacceptable: they know that the private sector is always more efficient than the government, and no amount of evidence will shake their faith. But that’s what
the evidence shows.

The administrative costs of private insurors are high for several reasons:

– New business acquisition: Each insured is paying for what insurance companies like to call “new business acquisition” which is a fancy name for advertising, direct mail, golf tournement sponsorships,
websites and other marketing and sales tools. Depending on the company, acquisition costs can consume anywhere from 3% to 20% of each premium dollar.

– Underwriting charges. Unlike the Canadian or British systems which covereveryone, American insurance companies underwrite each individual policy before it is issued; group plans are underwritten every year
based on claims experience and one major claim – such as an employee who has a heart attack or is diagnosed with cancer – raises everybody’s premium.

– Commissions to agents. Every health policy pays the selling agent a commission of roughly 10% each year the policy – group or individual – is in place. In addition, agents are paid bonuses
for writing a large number of policies as well as for keeping business on the books. Thus, a top flight agent can be paid 15% of the premium, or more, year after year.

– Investment reserves. Insurance companies invest policyholder premiums in various instruments: Bonds, government securities, real estate and stocks. Investment income is supposed to help defray general overhead
and widen the profit margin but, when markets perform poorly, an insurance company is stuck having to raise premiums to make up for either a shaky market or its own poor investment strategy.

I’ve read that an insurance company needs a health policy to be on the books for something like three or four years without any major claims before the policy becomes profitable.

A public option would have few, if any, of these expenses and thus administration charges have to be lower.

As a 70 year old retired person with an employer contribution to my Medicare Advantage plan I can tell you that the administrative cost is high because the insurance companies have created so many plans and no one
in their offices knows what is covered even when you are reading the plan to them. Therefore in order to get something approved you have to file a grievance. People are concerned about government bureaucracy
well the insurance companies have it ten fold!

Also one has to take into account the administrative costs incurred by doctors and hospitals (and enrollees) in transactions with private insurers when compared with Medicare. There is an army of employees hired
by hospitals and doctors to handle claims, length of stay, eligibility verification, etc. All those would be unnecessary in a Medicare only situation. This is an argument in favor of a single payer but would
not change in a multiple payer system. Or maybe it would, for example, insurance companies might be forced to simplify the different transactions to be able to compete with a public plan.

Another example of the kind of thing that contributes to the administrative costs of private insurance is subrogation, which is a process by which an insurance company can assume your right to sue a third party
for damages. So, if you show up at the emergency room with an injury resulting from an accident, a whole department of the insurance company jumps into action, looking for someone to sue so they can recover
some of the money they’re paying out to the hospital.

This is bad enough already, but some insurance companies compound this by being really inefficient with this process. I once went into the hospital with a dislocated shoulder and a couple days later I got a questionnaire
about how I came to have a dislocated shoulder. I filled it out and sent it in. A day or two later, I got the same questionnaire again. I assumed it had been sent twice in error and ignored it. Same thing for
the multiple copies I continued to receive. A couple months later, I get a bill from the hospital showing that insurance had paid nothing. Upon calling my insurance company, I found out all the repeated questionnaires
had not in fact been sent in error but had been for each individual line item on the hospital bill and they wouldn’t move on any part of the claim until all the questionnaires had been submitted. So,
the line item for the x-ray got its own questionnaire, as did the line item for the painkillers, and so on and so forth. You can see the problem, right? The circumstances that put me in the hospital aren’t
going to change between the triage and the x-ray, or between the x-ray and the reduction of the shoulder, or if the hospital charges me for a gown. How much overhead is added by processing the exact same information
a dozen times for each case?

This still assumes that low admin. costs are necessarily a good thing. There’s a case to be made that higher admin costs in managed care actually pay for higher quality, better coordination of records, more
utilized preventative services, and the like, which can drive down costs elsewhere. Some argue that Medicare’s admin costs are too low. Admin costs after all are only an accounting measure, not a measure
of total costs or benefits.

“This seems like fairly overwhelming evidence that single-payer systems do, in fact, have low administrative costs compared with private insurers. To argue that this doesn’t clinch the case, you have
to resort to pretty desperate expedients; for example, one of my commenters says that the CBO study of administrative costs can’t be trusted, because Democrats control Congress. (The CBO bends over backwards
to be nonpartisan — and anyway, the study was done in 2006, when Republicans were still in control.)”

Why spend time commenting on the “Democrats control Congress” post (which any normal person would consider absurd) and not address the cost per beneficiary argument (which many people consider to AT
LEAST be worthy of further discussion)?

I love the Internet because I get to tell a Nobel Laureate and John Bates Clarke Medal Awardee that he is missing the point. Professor you are missing the point.

1. We can’t compare Medicare Advantage (“MA”) to Medicare Fee for Service (“FFS”) because MA plans must compete with one another for business while FFS has automatic enrollment. 2. We can’t compare Canada’s single payer with the proposed public option because the public option would have to compete with private plans for business. 3. We can’t compare Canada’s
single payer with the proposed public option because the public option would not be able to impose Medicare pricing due to competition from private manage care plans.

I think any discussion about the public option has assumed that providers will simply accept Medicare rates (or Medicare + 10%) for new enrollees in the public option. What if they don’t? What good will the
public option do patients of nobody will accept the insurance (this is happening right now in California with Medi-Cal (California’s Medicaid)?

In addition to the administration costs detailed by Charley James, executive salaries and bonuses far exceeds anything offered to administrators in Canada. and, of course most private insurance companies must show
profits and pay dividends which also add to financial administrative costs.

High administrative costs aren’t necessarily bad. If those dollars actually lead to a postive return, higher administrative costs could actually lead to a more efficient system. In particular, if Medicare
were allowed (they can’t spend more on administrative costs now because their admin spending is mandated by law) to increase administrative costs associated with monitoring outcomes and improving the
quality of care/cost of care trade-off, the system might be more efficient.

I am open to being wrong but you have yet to convince me that you are right. The issue with single payer is doctor choice and time to treatment. You have never written about these topic in regards to health care.
If you wish to convince someone on the fence like myself, you must incorporate what will happen to these two variables. Single payer could be cheaper as a result of lower quality, it could have higher cure rates
as a result of covering a larger, healthier universe. It could have lower life expectancy as a result of rationing and increase difficulty of receiving treatment. You have a lot of work to do. I give your coverage
of this topic so far a C. However, I would love to see some A work. I don’t know why you do not include all of the potential variables in you explanations but it does cause the unconverted to wonder if
the exclusion is intentional to hide ideologically embarrassing information. To be fair, this surely happens on the right as well, but I guess I hold you to a higher standard.

Is it not well understood that a huge chunk of the administrative costs in private insurance go to a) trying to segment the population ever more finely so as to only offer insurance to people who are likely to remain
healthy and b) finding ways to avoid paying the claims of those people who manged to slip into the system and were injured or became sick.

Single payer doesn’t bother with either of those tasks and consequently is way cheaper to administer.

Even if you’re not a advocate for single-payer healthcare, this seems pretty obvious.

I wrote this in your last post, but I’ll repeat it again because it’s still valid.

The problem is with Heritage’s contention that “per-capita” administration costs are a valid measure of comparison (they aren’t). The individuals themselves, as the article acknowledges,
are not comparable, as they come from two very different age brackets and have very different amounts of medical needs. Comparing the per-capita administrative costs is entirely apples to oranges when done this
way.

A more valid comparison would have been to compare the “per-visit” or “per-treatment” administrative costs of medicare versus private plans, the same way a normal company’s administrative
costs are compared on a per-unit volume sold basis, rather than on a per-customer-in-their-database basis. This makes sense intuitively anyway. The elderly don’t have higher health care costs because
the procedures and treatments they use cost more than similar procedures done on non-elderly. They have higher costs because they use that care more often, which is all that matters anyway. As it is, medicare,
just like private plans, bills per treatment, not per customer. The fact that Heritage glossed this over is grossly misleading.

Comments 5, 6 Clains denial is a big expense, but a profitable one for these companies. Drives Drs. and patients crazy- good use of our drs. time, right? I do see some merit in the argument that admin expense
is not all bad, IF it is actually directed to producing better health outcomes for patients, and there is some of that in present system, such as attempts to coordinate care for diabetics, but mostly it seems
to be about the financial health of these companies, or perks of their bosses, as others have noted. A truly public system with strong public health focus as well as continued basic research ought to be
able to give better outcomes at lower costs. No need for “nationalised” health care like UK’s NHS, simply single payer. Hell, I’d take the public option Obama proposed. There are
so many good ideas that we already know about- such as improved sanitation practices in hospitals; I think physicians ought to be offered a deal that malpractice would be handled by fair arbitration in return
for stronger reporting requirements when they know of errors/ malpractice. Finally, if carbon tax makes people exercise more, ride, walk, leads to communities designed for this it could help our population’s
health…

I’m glad you understand my initial argument, and I agree that more comparisons would be better.

However, Medicare Advantage is not a good comparison for two reasons:

First, it is not a “different system serving a similar population.” It is a different system serving a different population. Medicare beneficiaries who rate their health status as “fair,”
“good,” “very good,” or “excellent” are twice as likely to chose Medicare Advantage as those who rate their health status as “poor.” Those who qualify
for Medicare based on age are twice as likely to choose Medicare Advantage as those who qualify based on disability or end-stage renal disease. In short, Medicare Advantage gets the healthiest Medicare Patients.
(Figures from the Medicare Payment Advisory Commission June 2008 Data Book, page 62 [page 73 of the PDF file].)

Second — and this reason is far more important — administrative costs incurred by Medicare Advantage plans (as measured by the CBO report) include not just the cost of running the health plan, but
also costs of administration by providers; that is, costs incurred by doctors and hospitals.

In the “traditional” Medicare fee-for-service system, reported administrative costs include only those costs incurred at the level of administering the health plan. Administrative costs incurred by
doctors and hospitals are included in the payments made to those doctors and hospitals. For example, in the physician fee schedule, there is a category called “practice expense,” which is intended
to take into account the cost of running a medical practice besides the physician’s time and effort. Practice expense represents 45% of total physician payments, and 38.4% of practice expense is for administrative
costs. (These are CMS figures for 2005). This means that 17.3% of payments to physicians represent physcian-level administrative costs. These costs that are not included in the administrative costs for “traditional”
fee-for-service Medicare — but the corresponding costs are included in the CBO figures for Medicare Advantage. (There is a similar figure for hospital payments.)

That 17.3% is higher than Medicare Advantage’s administrative costs even before you add in traditional Medicare’s program-level administrative costs. That amount is: according to Hacker, 2%;
according to CMS, 3%; and including support for Medicare by government agencies other than CMS, 6%.

If you really insist on comparing administrative costs as a percentage of total costs using CBO’s figure of 16.7% for Medicare Advantage, the corresponding figure for traditional, government-run Medicare
is in the range of 19% to 23%.

You and Hacker are counting practice-level administrative costs for Medicare Advantage but not for government-run Medicare.

In short: It’s really easy to make Medicare administration look cheaper if you start out by excluding more than three-quarters of their costs!

Comparing Canada’s system is equally spurious, unless you can demonstrate that the figures you quote for Canadian administrative costs represent the same functions as the U.S. administrative costs to which
you are comparing them.

And of course, the whole idea of comparing administrative costs as a percentage of total costs is something that is really silly and stupid, given that administrative cost is not a function of total health care costs.

You say you are comparing “apples to apples.” But you aren’t, and you aren’t even comparing apples to oranges. You are comparing one section of an orange to an entire meal and claiming
we should prefer the section of an orange because it costs less to package.

Of course, Charley James’ comment above is partially correct — private plans do have to spend on marketing, underwriting, investment reserves, profits, and so on. And even without having to pay for those things, Medicare still spends more on administration. Listing those costs doesn’t prove Medicare is cheaper — it shows how inefficient Medicare really is, since it has higher spending even without those costs.

You say, “some people find that answer unacceptable: they know that the private sector is always more efficient than the government, and no amount of evidence will shake their faith. But that’s
what the evidence shows.”

On the contrary — you “know” that government is always more efficient — and you certainly aren’t letting the facts get in the way of your faith.

We have a third comparison point as well – the Veteran’s Administration. Which compares favorably to private insurers and HMOs on many dimensions (in spite of its problems and occasional horror stories).
Cost, administrative overhead, patient satisfaction. Interestingly, satisfaction for govt.-run veteran’s life insurance also runs high.

What about the cost of elections? Don’t politicians have to get elected? If government holds more power, the stakes in the election are raised causing more money spent on election campaign. Aren’t
these costs same as the advertising, marketing costs, and sales commissions that private insurers incur?

To the extent I understand Medicare Advantage, it also provides some benefits Medicare alone doesn’t (“top ups,” etc.). So I am not sure you are comparing apples to apples here to begin with.

In any case, no one, including the Pres, is espousing a Medicare-like plan unless it includes the very cost reductions all of Medicare (“Advantage” or not) requires.

Can we stop pointing to a public plan that may make its beneficiaries “happy” (because they don’t pay for it) but doesn’t always provide the best or most cost-effective treatment? The
sticking point is what is both “best” and “cost-effective.” There may well be a tension between the two but to ignore this tension and not talk turkey is a missed opportunity.

like many people, commentor #13 confuses financing of health care and delivery of health care. a single-payer financing system has nothing directly to do with choice of doctor or time to treatment. it has solely
to do with the issue of how we aggregate funds to pay for the people who are covered under any given system of health care delivery.

if i understand correctly, among the developed nations every one but the U.S. has a single payer financing system, but only Britain has a totally government-run system of delivery.

commentor #13 also apparently has not been paying attention to the many studies that look at quality of care. at least one of these has recently demonstrated that there is significant variation in quality of care
within the U.S., and that often the more expensive care is of lower quality.

there is also an issue of how we define quality. like many other words that may appear at first glance to be “objective”, quality is in the eye of the beholder. if you look solely at the availability
to at least a few people of advanced medical treatments, the U.S. is among the leaders. however, if your definition of quality includes the overall health status of everyone in the society, the U.S. is consistently
at the bottom of the developed nations — behind even Britain.

the issue is not which definition of “quality” is right or wrong. they are simply different, and reflect different underlying policy perspectives. what’s necessary is that we are honest with
each other (and ourselves) about how we define quality of care.

I can’t speak for the first. But time to treatment is a red herring consistently raised by conservative rags like the Wall Street Journal who argue, for example, that the average time to treatment in the
Canadian health care system is 17 weeks.

What they’re not telling you; this is the AVERAGE time to treatment, i.e. for ALL operations put together, from emergency situations to elective surgery. If you have a gunshot wound, a heart attack or any
kind of emergency, there is no waiting period. If your injuries are less severe, you have to wait a little longer. And so on, and so forth, until you get to completely elective surgery which does, in fact, take
a while, because frankly the medical system usually has more urgent things to do.

The other thing they don’t say is that there are also waiting periods in the U.S. for people without medical insurance. That would be the waiting period until 1) you collect enough money to buy insurance,
or 2) the waiting period until whatever medical problem you have develops into an actual emergency, at which point hospitals will be forced to treat you for free. Needless to say, that usually costs the hospital
more than it would have if they’d simply treated it early, as in Canada… yet another way our system is less efficient.

The bottom line is this; in a public health care system like Canada, the waiting periods are based around how badly you need care. In the current U.S. system, the waiting periods are based around how much money
you have. I prefer the first.